Much Ado About Reality

Inflation As An Economic Policy

Go to any library or college bookstore and find a first year textbook of economics. It will not matter which university professor has published that book, but all, except who are of the Austrian school of economics, will extol the virtues of inflation in the growth of any nation’s economy. If your economy is sluggish that inflation is just the thing to get your economy moving. And the spiel continues that one or two percent a year is good, keeps an economic growth pattern right in line with projections of abundant wealth. Inflation is necessary for good economic growth and is hammered into the students who must take these introduction courses. There is no debate, it is presented as fact and no discussion is allowed. It’s like saying that gravity never fails, always exists throughout the universe.

Yet for all this official cant, this inalienable truth presented to the world, there is not one shred of evidence that this assertion is true. Inflation is an economic god whose existence cannot be questioned. Don’t you find that strange? You might as well state that the divine right of kings is god’s truth. Of course we might ask that if two percent is good then why wouldn’t ten percent be even better? Oh ye of little faith, you who dare to question the gods of economic truth. Okay, so again, why wouldn’t ten percent make us all millionaires? Well, actually it could. The problem is that our pile of money would deflate in value and what good is being a millionaire if your hoard of cash is only worth ten dollars in real terms? Oh, so there’s a catch to this inflation ideal? Yep, you bet Red Ryder. You see, inflation is caused by too much money or purchasing power chasing too few goods and services. If our economy went from having only one goose who laid a golden egg (99.99% fine) each day to having ten geese laying one golden egg each per day then we would add ten percent more buying power, all things relative. And if all the population now had one goose each that laid that daily golden egg then our total purchasing power would be increased proportionately. Now if it took one golden egg to buy a one hundred caret diamond necklace and only one necklace could be produced each day, then we would have a price equilibrium, that is, supply would match demand. But if there were tend golden eggs being produced each day and only one diamond necklace then the demand would outstrip the supply. The price might rise to ten golden eggs. Or if the diamond necklace producers were really greedy, they might start putting only 90 carets of diamonds in each necklace and still charge ten golden eggs. The difference is that after nine days they would gain an extra necklace to sell.

This is how inflation works. When there is more money or credit, which is almost exactly the same as cash because it spends just like cash for most purposes, then we have more money chasing after the same amounts of goods and services. And if you are in business you are going to raise your prices according to the demand and you will cut the quality, quantity, or other perception of value so that you can make more money. Now the funny thing is, that inflation tends to be a push/pull effect on the economy. If there is a shortage of food such as poor harvests and fewer animals to slaughter, then food prices go up. The average consumer has little power to work against this increase, all he can do is to choose cheaper alternatives to purchase. Unfortunately these cheaper alternatives do not remain cheap for long. When the price of cow’s milk goes up we might see people start drinking goat’s milk or a soy milk product. Where the lower demand and the quality perceptions had kept the prices down, the increase in prices for cow’s milk increase the demand for the alternative or substitutes and their prices will increase because demand pushes them up. Once supply normalizes to demand we will see the prices retreat a little but never to their former levels. Inflation caused by an increase in the money supply has pushed the prices of goods and services higher and the only way that they will fall to previous levels or lower is through deflation or the lack of money in circulation. Are you with me so far? The pull side of inflation is the corresponding wage problem. That is, if prices rise and wages are arbitrated by a Consumer Price Index, then raises are triggered by rising prices and the next round of inflation begins.

But let us say that calamity hits the land. We have allowed the formation of credit, that is the buying of the future today, and now payment comes due. Ah, such a problem does exist and has for a great many centuries, for all economies eventually fall for that trap. When we have consumed the future, usually by buying too many assets or what we think are assets, and then can pay for them. Many individuals believe that an automobile is an asset but it really is a liability, that is, you end up having to pay a premium for the vehicle that continues to depreciate, you need to spend money on its upkeep, license, and insurance, and its operation. And if you try to sell that vehicle then you find out that it hasn’t paid for itself. If you buy a house, a residence in which you live, then you have what most people think is an asset. But if you bought the house at far too high a price with far too low a down payment and far too high a mortgage payment you find that if the price bubble breaks the value of your asset is far less than the value of your mortgage. And if you lose your job and can’t make the mortgage payment you now have a real problem. Inflation caused your problem (well, part of it, your own foolishness of buying what you could not prudently afford is the other cause) of buying an over inflated asset and deflation is the cause of your under valued asset that you must still pay off at an over inflated price.

The fact of the matter is that labor unions are part of the cause of inflation since they seldom will, even during a severe recession, take lower wages for their members. The union believes that the constant push for increasing wages and benefits is of paramount importance for its membership. Yet such policies drive its members out of the local job market. And the concentration of industry, while it does allow for the economies of scale that benefit only corporations and not the general public, tend to push prices higher. Consider this consumer product. A television set has decreased in price relative to its technology. One can buy the same size television screen for twenty dollars today that would have cost two hundred dollars in 1947. But we now spend several thousand dollars of sets that have extremely large screens. In relative terms, we tend to spend a little more on our entertainment systems that we did in 1947. We do so because our televisions are specialized and need paid for programming. Very few people these days are limited to the old air wave local channels for their entertainment, most are subscribers of CATV or Satellite services and now the push is towards internet providers supplying the content models at a price.

So now the ECB, or European Central Bank, is going to start buying 60 billion euros worth of government securities from the various EU governments, Greece being the exception. This is in an effort to create inflation by causing investors to buy riskier investments. Notice that none of this money will go to buy the excess food being produced and no longer shipped to Russia due to trade restrictions by order of political sanctions. Simply put, the farmers are growing too much wheat, corn, vegetables, fruit, and so forth. But consumers aren’t buying as much because the unemployed numbers have risen, more people are out of work that means they buy less and cheaper substitutes. If you want inflation, pay people not to work and they will use that money to buy more stuff they want and can afford. the Euro will be in parity or lower by the end of this year. You like French Bordeaux, good, cause it will get a lot cheaper come next fall. The 2009 La Romanee Conti that was selling for $25,000 at CDG airport will only command $17,500 next fall. What a deal!